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Berkowitz on Consuelo Mack


Myth465
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I like how he mentioned that FAIRX currently has $4 a share in earnings versus its current $27 unit price.  A nice 15% earnings yield plus you get BB at 1% annual fee and no performance fees :)

 

FAIRX (the current "laughing stock" of the fund world) 15% Earnings Yield

AAPL (the current "superstar stock" of the equity world) 6.31% Earnings Yield

 

http://ycharts.com/companies/AAPL/earning_yield

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I finally got a chance to watch this.  I thought he did a very good job.  Sure, he didn't say anything new, but there really isn't anything new to say.  The thesis is what it is.  She asked some tough questions I thought and he handled himself very well.

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he said bac book value could double in ten years not aig. that's only a 7.2% growth btw. but he does think bac will pay out quite a bit of earnings as divdends and buy back stock as well.

 

BAC is trading at P/B of 1/3. If BAC goes back to P/B of 1 at 2021 and doubles its BV in the meanwhile, that's a 20% CAGR for 10 years.

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I think it is easy to take Berkowitz at face value.  He knows financials, has had very good call in the area in the past, and the situation looks similar.

Problem is nobody really knows what the real book value is at banks, the financial system is very stressed, so this time it is different.

 

Look at the record of Sprott vs. Berkowitz the last dozen years or so.  Sprott has outperformed Berkowitz much more than Berkowitz has outperformed the market.  Sprott is short financials, Berkowitz is long.  On the basis of the track record, I'd go with Sprott...

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I think it is easy to take Berkowitz at face value.  He knows financials, has had very good call in the area in the past, and the situation looks similar.

Problem is nobody really knows what the real book value is at banks, the financial system is very stressed, so this time it is different.

 

No it isn't different.  Look at what the bears said about banks back in the early 1990s.

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Not specific to BAC.  Specific to all very levered financial institutions. The leverage in Europe, in regional governements in the US, in regular citizens create so many black swan potentials.  Now, BAC also has lawsuit issues but this is the icing on the cake.

 

So far Berkowitz has been definitely wrong on the financials lately.  Maybe time will prove him right but he has definitely been very early...

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Not specific to BAC.  Specific to all very levered financial institutions. The leverage in Europe, in regional governements in the US, in regular citizens create so many black swan potentials.  Now, BAC also has lawsuit issues but this is the icing on the cake.

 

So far Berkowitz has been definitely wrong on the financials lately.  Maybe time will prove him right but he has definitely been very early...

 

What the hell does the market price have to do with his being right or wrong?

 

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Not specific to BAC.  Specific to all very levered financial institutions. The leverage in Europe, in regional governements in the US, in regular citizens create so many black swan potentials.  Now, BAC also has lawsuit issues but this is the icing on the cake.

 

So far Berkowitz has been definitely wrong on the financials lately.  Maybe time will prove him right but he has definitely been very early...

 

 

What the hell does the market price have to do with his being right or wrong?

 

 

One of my favorite parts of the Consuelo Mack interview -- "In February, I was a hero. Now, I'm a bum. So we'll see six months from now." ~ Bruce Berkowitz

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Look at the record of Sprott vs. Berkowitz the last dozen years or so.  Sprott has outperformed Berkowitz much more than Berkowitz has outperformed the market.  Sprott is short financials, Berkowitz is long.  On the basis of the track record, I'd go with Sprott...

 

Has Sprott elaborated on his short thesis?

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Great interview, finally watched it.

 

CM does a great job of revisiting things that BB said in their last interview. One that was memorable about his worst nightmare of being forced into a corner with concentrated investments and very little cash. Also the huge drop in available cash in the fund.

 

This will be a trying time for BB given the concentration in financials and his quickly dwindling cash. It should cause increased price volatility in many of his financials if he's force to trim pro-rata in his high conviction names.

 

It was nice to watch this interview after reading his 1990 piece on WFC. My worry today in comparison to the past is the heavy amount of notional derivatives on the books of many of his financial names. I worry about the effect when various parties of those contracts can't meet their obligations especially in light of high volatility in the underlying assets from commodities to interest rates.  2008 to 2009 was one test of those derivatives and now we enter another test.

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Great interview, finally watched it.

 

CM does a great job of revisiting things that BB said in their last interview. One that was memorable about his worst nightmare of being forced into a corner with concentrated investments and very little cash. Also the huge drop in available cash in the fund.

 

This will be a trying time for BB given the concentration in financials and his quickly dwindling cash. It should cause increased price volatility in many of his financials if he's force to trim pro-rata in his high conviction names.

 

It was nice to watch this interview after reading his 1990 piece on WFC. My worry today in comparison to the past is the heavy amount of notional derivatives on the books of many of his financial names. I worry about the effect when various parties of those contracts can't meet their obligations especially in light of high volatility in the underlying assets from commodities to interest rates.  2008 to 2009 was one test of those derivatives and now we enter another test.

 

http://www.zerohedge.com/news/five-banks-account-96-250-trillion-outstanding-derivative-exposure-morgan-stanley-sitting-fx-de

 

The latest quarterly report from the Office Of the Currency Comptroller is out and as usual it presents in a crisp, clear and very much glaring format the fact that the top 4 banks in the US now account for a massively disproportionate amount of the derivative risk in the financial system. Specifically, of the $250 trillion in gross notional amount of derivative contracts outstanding (consisting of Interest Rate, FX, Equity Contracts, Commodity and CDS) among the Top 25 commercial banks (a number that swells to $333 trillion when looking at the Top 25 Bank Holding Companies), a mere 5 banks (and really 4) account for 95.9% of all derivative exposure (HSBC replaced Wells as the Top 5th bank, which at $3.9 trillion in derivative exposure is a distant place from #4 Goldman with $47.7 trillion). The top 4 banks: JPM with $78.1 trillion in exposure, Citi with $56 trillion, Bank of America with $53 trillion and Goldman with $48 trillion, account for 94.4% of total exposure. As historically has been the case, the bulk of consolidated exposure is in Interest Rate swaps ($204.6 trillion), followed by FX ($26.5TR), CDS ($15.2 trillion), and Equity and Commodity with $1.6 and $1.4 trillion, respectively.
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Without knowing the composition. This article is pretty meaningless.

 

Here is a link to the most recent Q2 2011 report. If you scroll to the end of the report, you'll find all the specific numbers and composition of exposure.

http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq211.pdf

 

Also here is the general link for other quarterly reports from the OCC.

http://www.occ.treas.gov/publications/publications-by-topic/capital-markets/index-capital-markets-pubs.html

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For risk and capital purposes, virtually all of those derivatives between the big financial institutions are collateralized so the risk is really the movement between collateral calls.  That's what killed AIG, not the realized losses on the derivatives but when they got downgraded it triggered collateralization of the derivatives.  It doesn't negate the fact there's billions of exposure but it's not as bad as the notional amounts the press loves to quote.

 

Now if the collateral is US Treasuries.....but that's another discussion.

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For risk and capital purposes, virtually all of those derivatives between the big financial institutions are collateralized so the risk is really the movement between collateral calls.  That's what killed AIG, not the realized losses on the derivatives but when they got downgraded it triggered collateralization of the derivatives.  It doesn't negate the fact there's billions of exposure but it's not as bad as the notional amounts the press loves to quote.

 

Now if the collateral is US Treasuries.....but that's another discussion.

 

I would like to understand this risk better because it's making me hesitant to invest in the major banks.

 

In terms of the interest rate and currency derivatives, I agree the notional amounts tend to over estimate the exposure. However, banks like Wells Fargo are writing a decent amount of credit protection. They mitigate some of this risk with purchased credit protection for some of the their written exposure but not all of it. They are sticking themselves in the middle of the derivative chain instead of following the insurance approach where they just act like brokers.

 

The exposure to credit derivatives looks like it will continue to grow along with all the other exposure through interest rate, fx, and commodities at the banks. Why do you think a similar event like AIG where they can't come up with collateral won't happen at another bank or someone in the derivative web defaults upsetting the balance?

 

I want to understand how people are getting comfortable with this growing (what I think) is a big risk in the major banks.

 

I also attached WFC latest annual derivative exposure to credit protection sold and purchased.

Credit_protection_sold__purchased_WFC_2010_AR.pdf

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I'm sensitive to the person who noted that this is probably the wrong board for this discussion but....

 

I'm far from a complete expert on this but I was a risk manager for one of the big banks for a long time so I'm fairly familiar with the workings.  And from that I can say that as an investor you can NEVER know what the true risk is at any bank.  You know how much the exposure is on a single day and the nature of it but the details are sooooo much more complicated.  Plus there's the fraud risk (just ask UBS).

 

Rarely do banks like WFC or BAC use credit derivatives for outright positioning purposes.  They are generally purchased as a hedge or in an arbitrage situation.  This is probably even more true now that the trading books are being minimized and shut down.  For example, WFC might lend $100m to General Motors.  This is usually done, however, not because the loan is such a great asset but because they have to do it to win more lucrative FX, asset management or other business from GM.  Not wanting the GM exposure they will buy $100m (or less) of CDS on GM as a hedge.  If the hedge is an accurate one, this not only gives them protection against default of GM but also means they don't have to hold as much capital against the loan so it's win-win.  In an arbitrage situation, they might buy $100m of GM bonds that pay a spread of 200bps and sell CDS credit protection on $100m that generates an income of 220bps - thereby keeping 20bps/year.  The notionals are big but the risk is actually fairly minimal.

 

On the counterparty risk:  there are generally 3 sellers of CDS (ie providing the protection) - banks, hedge funds, insurance companies.  These days, virtually all of the trading of derivatives between these parties is done on a fully netted and collateralized basis.  That means that every day they mark all the positions between them, net off all the +'s and -'s and then whoever is out-of-the-money posts collateral in that amount to the other.  The AIG situation where you are uncollateralized unless the counterparty is downgraded is now a thing of the past.  For hedge funds, they generally have to post excess collateral

 

From a capital perspective, any exposure that's fully collateralized gets a far reduced (or zero) capital requirement.  The capital requirements on derivatives are extremely complicated and not all that well developed (they try hard but it's such a broad category it's tough to accurately capture it).

 

This is a VERY simplified discussion but I hope it points you in the right direction.  The reality is about 100x more complicated and intricate.  I reiterate though that nobody on the outside will ever be able to fully understand the amount, nature and risks of the exposure at the banks.  This is true not just of derivatives but also the general loan/securities books.  BB is a genius and probably has done more work on it than anyone but, in my view, with banks you're really betting on the big picture and management.

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